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I’ve long expressed my displeasure with the specific approach
implemented by the Bernanke Fed. I am admittedly hard on
Dr. Bernanke at times, but I think much of their framework is
based on a flawed ideology and misunderstanding of the way the
economic machine works. In today’s press conference Q&A Dr. Bernanke said
something that I believe confirms this view. Pedro da Costa
asked how the transmission mechanism works and why QE is
different than trickle down economics since it seems to boost
Wall Street, but doesn’t do much else. The Fed Chief
answered:

“The tools we have involve affecting financial asset
prices. Those are the tools of monetary policy. There
are a number of different channels. Mortgage rates, other
rates, I mentioned corporate bond rates. Also the prices of
various assets. For example, the prices of homes. To
the extent that the prices of homes begin to rise, consumers will
feel wealthier, they’ll begin to feel more disposed to
spend. If home prices are rising they may feel more may be
more willing to buy home because they think they’ll make a better
return on that purchase. So house prices is one
vehicle. Stock prices – many people own stocks directly or
indirectly. The issue here is whether improving
asset prices will make people more willing to spend. One of
the main concerns that firms have is that there is not enough
demand…if people feel their financial position is better they’ll
be more likely to spend….”

This is a terribly flawed approach to public policy and it
underlines a serious flaw in the way the Central Bank is
implementing policy today. What Ben
Bernanke just described in the paragraph above is the exact
type of thinking that causes enormous distortions in markets and
the economy. This sort of thinking is a remnant of
efficient market style thinking that assumes asset prices
properly reflect the underlying economy at any particular time
and totally ignores the reality that Hyman Minsky often
discussed, which states that financial markets can become
severely distorted by the effects of ponzi finance and financial
instability. The reality of the market is that asset prices
do not always properly reflect their underlying values.
Asset prices reflect the
summation of the decisions of the inefficient participants who
are engaged in the buying and selling of those assets.This has been borne out time and time again as
irrational human decision making leads people to chase asset
prices and underestimate the degree to which stability results in
instability. The recent housing bubble and chasing of
assets should have made this more than abundantly clear, but
myths persist….

Furthermore, the idea that an economic recovery should be driven
by consumers who spend out of today’s income based on the
temporary increase in nominal wealth (which may or may not be
higher in the future) is completely backwards. As I
explained previously, this idea is similar to a CEO who
thinks she/he can improve her/his business by buying back her/his
stock ad infinitum. No, the CEO is there to generate growth
in the underlying assets. Not to jam up the price of stock
traded on a secondary market. The CEO who buys back stock
and foregoes real investment in the firm is generating a
temporary boost in nominal wealth that may or may not be backed
by real growth in the firm. What the US central bank is
implementing is very similar. It is an intentional attempt
to distort the price of financial assets in order to generate a
short-term gain that may or may not be justified by improvement
in the underlying assets. It is the very definition of
ponzi finance.

In my opinion, the explicit defense of the ponzi financial
policies that got us into this mess is totally indefensible.